Nominal Interest

(noun)

The amount of interest accrued per year without accounting for compounding.

Related Terms

Examples of Nominal Interest in the following topics:

  • Differences Between Real and Nominal Rates

    • The real rate is the nominal rate minus inflation.
    • In the case of a loan, it is this real interest that the lender receives as income.
    • If the lender is receiving 8% from a loan and inflation is 8%, then the real rate of interest is zero, because nominal interest and inflation are equal.
    • The real rate can be described more formally by the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate: 1 + i = (1+r) (1+E(r)), where i = nominal interest rate; r = real interest rate; E(r) = expected inflation rate.
    • The relationship between real and nominal interest rates is captured by the formula.

  • The Fisher Effect

    • We only discussed nominal interest rates.
    • We did not adjust the nominal interest rates for inflation.
    • The Fisher Effect relates nominal and real interest rates and we define the notation as:
    • Financial analysts always write interest rates for financial instruments in nominal terms.
    • If investors and the public have higher expectations of inflations ( πe ), then nominal interest rates (i) become greater.

  • Comparing Interest Rates

    • The reason why the nominal interest rate is only part of the story is due to compounding.
    • Since interest compounds, the amount of interest actually accrued may be different than the nominal amount.
    • To find the real interest rate, simply subtract the expected inflation rate from the nominal interest rate.
    • Thus, Company 2 is the better investment, even though Company 1 pays a higher nominal interest rate.
    • The nominal interest rate is approximately the sum of the real interest rate and inflation.

  • Macroeconomic Factors Influencing the Interest Rate

    • In economics, a Taylor rule is a monetary-policy rule that stipulates how much the Central Bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions.
    • In particular, the rule stipulates that for each 1% increase in inflation, the Central Bank should raise the nominal interest rate by more than one percentage point.
    • According to Taylor's original version of the rule, the nominal interest rate should respond to divergences of actual inflation rates from target inflation rates and of actual Gross Domestic Product (GDP) from potential GDP:
    • In this equation, it is the target short-term nominal interest rate (e.g., the federal fund rates in the United States), πt is the rate of inflation as measured by the GDP deflator, π*t is the desired rate of inflation, r*t is the assumed equilibrium real interest rate, yt is the logarithm of real GDP, and y*t is the logarithm of potential output, as determined by a linear trend.
    • Describe how the nominal interest rate is influenced by inflation, output, and other economic conditions

  • Calculating Values for Different Durations of Compounding Periods

    • The EAR can be found through the formula in where i is the nominal interest rate and n is the number of times the interest compounds per year (for continuous compounding, see ).
    • You can think of it as 2% interest accruing every quarter, but since the interest compounds, the amount of interest that actually accrues is slightly more than 8%.
    • In this equation, A(t) corresponds to FV, A0 corresponds to Present Value, r is the nominal interest rate, n is the number of compounding periods per year, and t is the number of years.
    • The equation follows the same logic as the standard formula. r/n is simply the nominal interest per compounding period, and nt represents the total number of compounding periods.
    • Finding the FV (A(t)) given the PV (Ao), nominal interest rate (r), number of compounding periods per year (n), and number of years (t).

  • Calculating the Yield of a Single-Period Investment

    • Nominal APR is simply the interest rate multiplied by the number of payment periods per year.
    • However, since interest compounds, nominal APR is not a very accurate measure of the amount of interest you actually accrue.
    • Interest usually compounds, so there is a difference between the nominal interest rate (e.g. monthly interest times 12) and the effective interest rate.
    • The Annual Percentage Yield is a way or normalizing the nominal interest rate.
    • Basically, it is a way to account for the time factor in order to get a more accurate number for the actual interest rate.inom is the nominal interest rate.N is the number of compounding periods per year.

  • The Demand for Money

    • Generally, the nominal demand for money increases with the level of nominal output and decreases with the nominal interest rate.
    • Specific to the liquidity function, L(R,Y), R is the nominal interest rate and Y is the real output.
    • However, when the demand for money is not stable, real and nominal interest rates will change and there will be economic fluctuations.
    • The interest rate is the rate at which interest is paid by a borrower (debtor) for the use of money that they borrow from a lender (creditor).
    • Interest-rate targets are a tool of monetary policy.

  • Shifts in the Money Demand Curve

    • The nominal demand for money generally increases with the level of nominal output (the price level multiplied by real output).
    • The interest rate is the price of money.
    • The demand for money shifts out when the nominal level of output increases.
    • It shifts in with the nominal interest rate.
    • The nominal interest rate declines and there is a greater interest advantage in holding other assets instead of money.

  • Relationship Between Expectations and Inflation

    • Anything that is nominal is a stated aspect.
    • Suppose you are opening a savings account at a bank that promises a 5% interest rate.
    • This is the nominal, or stated, interest rate.
    • The real interest rate would only be 2% (the nominal 5% minus 3% to adjust for inflation).
    • The difference between real and nominal extends beyond interest rates.

  • The Nomination Process

    • It is the president's responsibility to nominate federal judges and the Senate's responsibility to approve or reject the nomination.
    • The president nominates all federal judges, who must then be approved by the Senate .
    • Interest groups: Nominees must be acceptable to interest groups that support the president.
    • Nominations go to the Senate Judiciary Committee, which usually holds hearings.
    • Federal judges, such as Supreme Court Justices, must be nominated.